How Are Money Market Account Yields Determined?

Money market deposit accounts are a compelling choice for cash managers seeking a safe place to store emergency cash while earning a higher interest rate than they could in a standard deposit account. The rate of return on money markets varies widely between banks, even within the same geographical area, so the decision of which account to use requires some analysis.

Banks have autonomy to set their own rates for deposit accounts, including money markets, but there are many factors that influence this decision. By understanding the mechanics of how yields are determined, cash managers can more confidently navigate the marketplace and secure competitive returns that strengthen their organization’s bottom line.

Regulatory Factors Drive Money Market Yields Across the Nation

Interest rates in the U.S. are influenced by the “invisible hand” of the Federal Reserve [Fed]. This independent body is tasked with maintaining moderate inflation and full employment, and they have several tools with which to accomplish this task. The Federal Funds Rate, reserve requirements, and quantitative easing are the most obvious of these tools, and they can influence the rates banks pay for money market deposits.

The Federal Funds Rate

The primary tool in the Fed’s arsenal is the Federal Funds Rate – often shortened to the Fed Funds Rate. This is the interest rate at which commercial banks borrow and lend excess reserves to each other overnight.

When the Federal Open Market Committee [FOMC] raises the Fed Funds Rate, it becomes more expensive for banks to borrow money from one another. Consequently, rates for other loans, like those that banks offer their customers, often rise to accommodate higher costs of borrowing.

Banks can also earn more from lending when rates rise, so in turn, they might pay more for deposits to fund those loans. This is a key reason why an increase in the Fed Funds Rate often leads to higher yields for money market accounts.

The opposite is also true. A decrease in the Fed Funds Rates makes borrowing among banks cheaper and lending less profitable. As a result, banks pay less to borrow from other banks, and they will also pay less for deposits. Keep in mind, any change in deposit rates often lags an FOMC decision, because these changes take time to work through the banking system.

Reserve Requirements

The Fed is also tasked with setting reserve requirements for banks – the balance of cash they must maintain to meet customer withdrawal requests. Changes to these requirements have historically been infrequent, so their effect on borrowing rates is generally neutral – barring a major change in regulation.

When reserve requirements are increased, banks must keep more cash on hand – meaning fewer dollars are available for lending. The smaller supply of funds means there will be more competition for funds among borrowers – pushing rates up. Conversely, lower bank reserve requirements have the opposite effect on rates.

Quantitative Easing and Tightening

The final tool that the Fed can use to influence the economy is management of the money supply through buying or selling securities on open markets. They use this method to affect the economy when other tools have failed to bring inflation and employment into balance.

Quantitative Easing [QE] involves buying debt securities to increase the supply of money in the economy. This increases bank liquidity, encourages lending, and puts downward pressure on interest rates – sometimes including deposit yields.

Conversely, Quantitative Tightening [QT] unwinds purchases made under a previous period of QE. The widespread sale of securities has the opposite effect on the economy and yields.

QE is typically applied during severe economic contractions, and QT generally follows once the economy has recovered to “unwind” a QE program. Therefore, this type of policy generally has a minimal impact on money market yields when the economy is stable.

Competition For Cash Drives Money Market Yields

While the Fed’s actions influence the banking sector as a whole, competition is the driving force behind dramatic differences in yields at different financial institutions. Each bank views corporate cash through a lens of its own needs and the competitive environment of its “neighborhood” – whether that is a physical city or a specific niche.

Bank Vs. Bank Competition

A bank’s willingness to pay high yields for funds in a money market account is often dictated by the number of other institutions hunting the same dollar. The number of banks competing for funds can depend on:

• Geography. Local banks often receive the majority of their deposits from a relatively small footprint, so the density of banks in their area influences their rates. Banks in highly concentrated areas may pay above-average rates to “poach” clients from the branch across the street, while those with few close competitors may pay less.
• Target Customers. Some banks don’t specialize in a particular geographical area, but a specific segment of the market. Competition of this nature can drive money market yields for depositors in a particular niche, regardless of other factors like geography.

Bank Vs. Other Investment Competition

Banks don’t just compete with other banks for cash. They also compete with accounts offered by credit unions and investments issued by governments or companies. The yields for these investments can also influence the rate banks must pay to attract new customers or avoid losing their existing ones.

Some popular alternatives to money market deposit accounts at banks are short-term Treasury securities and money market mutual funds. Neither is a perfect substitute for the safety and liquidity of a money market account, but some depositors may move their cash if they can achieve a much higher yield with one of these alternatives.

Consequently, banks may choose to raise the yields they offer for money market accounts to remain competitive with similar investments when yields for those options increase. On the other hand, banks may feel less pressure to improve their yields when alternatives are paying less.

In summary, banks that need to attract deposits generally offer higher-than-average rates of return. This creates a win-win situation for banks, who can meet their business needs, and companies, who can enjoy higher interest payments to support their bottom line.

Shopping for Above-Average Money Market Account Yields

Because yields for money market accounts vary so widely, a proactive cash manager can secure rates well above the national average by comparing rates from many banks and choosing the highest available. However, executing this strategy presents two major hurdles:

1. Time. There are over 4,300 FDIC-insured banks and over 4,300 credit unions in the U.S., and manually comparing their yields is a time-consuming endeavor. Further, financial institutions can change their yields at will, so tracking, vetting, and moving money to maintain an optimal ROI quickly becomes more cumbersome than most finance departments can handle.
2. Safety. The FDIC provides $250,000 in protection per ownership category at each insured bank, and the NCUA provides equal protection at credit unions, but many companies have far more than this in reserve. Achieving full protection requires accounts at multiple financial institutions, which further complicates this cash management strategy.

Fortunately, there is a simple solution to these problems.

Deposit Management from ADM Provides Nationally Competitive Interest Rates

At American Deposit Management, we simplify the cash manager’s quest to maximize interest without sacrificing safety. Our deposit management solutions use patent-pending technology to spread business deposits across a nationwide network of banks and credit unions – with a single account and monthly statement.

In turn, our customers earn an average of 7x the national average money market yield without sacrificing safety or liquidity. We also take the work of managing multiple banking relationships off their plate and provide access to unlimited government insurance from the FDIC or NCUA. Additionally, our customers retain simple access to their cash with next-day liquidity.

To learn more about our solutions and get started, contact us today.

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